Financial and Management Accounting Unit 8

Unit 8 Introduction to Management Accounting

Structure:
8.1 Introduction
8.2 Decision Making
8.3 Meaning and scope
8.4 Cost analysis
8.5 Budgetary control
8.6 Standard costing
8.7 Financial analysis
8.8 Relevant cost
8.9 Management accounting framework
8.10 Function of management accounting
8.11 Special features
8.12 Merits and Demerits
8.13 Distinction between M.A and F.A

8.1 Introduction
Management accounting is an accounting service to the management. It
assists the managers in the formulation of policy, taking a decision, control
of execution. It focuses in increasing the managerial efficiency. Hence
management accounting is also called as “Accounting for Management”.

Learning Objectives:
After studying this unit, you should be able to understand the following:
1. Spell out the meaning, scope, functions, special features, role of
Management accounting,
2. Expose the cost analysis,
3. Appreciate the budgetary control,
4. Deal with standard costing,

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5. Recognize the merits and demerits of management accounting,

6. Identify the differences between management accounting and financial
accounting,
7. Perform some basic financial analysis.

8.2 Decision Making as a Nucleus of Management

Decision-making in any business organization( individuals or groups of
individuals) is primarily a function of management. Decisions are normally
taken under uncertainty. Decision under trial and error or intuition will not
end in good results. Scientific decision need to be made from time to time.
For this, the management has to rely on the information supplied by
professionals and specialized agencies. One of the important components
in information collection is in the field of internal financial information.
Accounting acts as a basis upon which crucial decisions can be made. The
financial statements prepared in its traditional form may not convey the
required information for taking decisions. The financial information need to
be fine-tuned for use by the busy management. This function is being
performed by the management accounting.

Self Assessment Questions 1:

1. Decision making is a painful game (True or false).
2. Decision based on trial and error method bring in good results
(true/false).
3. Decisions are normally based on financial statements (true or false) .
4. Financial information need to be ________ For use by management.

8.3 Meaning And Scope

Management accounting is an accounting service to the management. It
covers all those services by which the accounting department can assist the
managers in the formulation of policy, taking a decision, the control of its
execution and the appreciation of effectiveness.

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As regards the scope of management accounting, it is very wide. It is based

on historical financial data. It is concerned with future. It uses the
information available from different walks of life like Political Science,
Statistics, Mathematics, Economics, Cost Accounting and Financial
Accounting. The main purpose of management accounting is to utilize
information in solving the business problems and taking scientific decisions.
Hence, it is difficult to pinpoint the exact scope. The Management
Accountant seek to support management decision making by the provision
of information and the analysis of financial performance. As the data is
required for internal purposes, the management accountant is not
constrained by the need to comply with regulations of the format for
presentations. The main scope is :
1. To identify and calculate costs of production. This is known as Cost
Accounting
2. To provide estimates for future expenses and revenues. This is known
as Budgeting
3. To identify inefficiencies within the organization
4. To control costs and manage the flow of cash
5. To seek opportunities e.g. to identify “tax breaks”, possible cost savings
and movements in foreign exchange rates which could be exploited by
the organization.

The main management accounting techniques are:

1. Break-even analysis
2. Costing
3. Budgeting
4. Ratio Analysis
5. Variance analysis

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Self Assessment Questions 2:

1. Function of accounting department is _______, ________, _______,
______ .
2. Main purpose of Management accounting is _______ and
______________ .

8.4 Cost Analysis

M.A take into account some of the concept of cost accounting technique.
The cost analysis is an important aspect. A management accountant has to
face questions such as “what will our cost be next year”. This deceptively
simple boundary question.

Such question can occur in virtually every aspect of work and knowledge of
the patterns of cost behavior and ways that future cost can be predicted is
fundamental requirement when concerns with decision makers.

8.5 Budgetary Control

Modern business world is full of competition, uncertainty and exposed to
different types of risks. The complexity of managerial problems has led to
development of various managerial tools, techniques and procedures useful
for the management in managing the business successfully. In this direction,
planning and control plays an important role. Budgeting is the most common
and powerful standard device of palling and control.

Budgetary control is a technique of managerial control through budgets.. A

budget is a quantitative expression of plan of action. . It is a pre-determined
detailed plan of action developed as a guide for future operation. According
to Wheldon “Budgetary control is the planning in advance of the various
functions of business so that the business as a whole can be controlled”.
Budgetary controls deals with planning, coordination, recording appraisal
and follow-up of actions.
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Self Assessment Questions 3:

1. Budget is ____________ _________________ Plan of action
2. Budgetary controls deals with _______, ________, _______, _____,
_____ .
8.6 Standard Costing and Variance Analysis
Businesses need to plan and budget for their future activities if their
objectives are to be achieved. Planning and budgeting are not enough. It is
necessary to monitor progress against the planned outcomes to establish
significant differences and to permit corrective action to take place. This
means that performance must be regularly assessed, differences identified
and plans revised.. Although the ultimate objectives may not change, the
way in which they are to be achieved may be very different and might make
additional demands on resources than originally anticipated.

A standard is a specified quantity or money amount that has been

estimated with reference to past experience and the future expectations of
efficiency levels, productivity and prices. Product or service costs can be
estimated by ascertaining amount of material if applicable, and direct
labour spent on each unit. This might be determined by observing what
quantity of material is used in a product and at which price it may be
purchased. It will also involve estimating how long a particular type of direct
employees spend on various aspects of making the product or providing the
service and what the various wage rates are for each type of labour
involved. Therefore, the setting of these standards is a subjective process.
The acceptable or desired standards may vary from manager to
subordinate, from individual to individual. Standard costing makes the
planning and budgeting easier and avoids the problem of completely
reformulating budgets every period. Standards also provide a controlling
mechanism where behavior is modified through motivation and appraisal.
Standard costing allows management to locate operational problems.

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Standard costing is best applied to manufacturing concerns where many

products are produced and their components numerous.

Deviation from standards is called variance. In budgeting language, a

difference is known as variance. Differences between budgeted and actual
performance will be referred to as variances.

8.7 Financial Analysis

It is the process of determining the significant operating and financial
characteristics of a firm from accounting data. An organization has to deal
with three areas viz. financial records and external reports, accounting for
management decisions and internal reports and finally financial assessment
and analysis. Financial statement analysis is therefore largely a study of
relationship among the various financial factors in a business . It is the
process of selection, relation and evaluation. The focus of financial analysis
is on key figures in financial statements and the significant relationship that
exists between them. The technique of financial analysis is typically
devoted to evaluate the past, present and projected performance of a
business firm. Financial analysis is commonly called “the analysis and
interpretation of financial statements”.

Self Assessment Questions 4:

1. An organization has to deal with three areas _______, _______ and
______ .
2. Financial analysis is also known as ____________________________ .

8.8 Relevant Cost

Management decision is based on relevant costs. Costs incurred in the past
is sunk cost. Whether to replace a machine or a not is a decision not based
on how much was invested to buy that machine. This is based on
comparative cash inflows from replacements and additional investments

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necessary net of realization of the old asset. Thus, sunk costs are not
relevant costs.

Thus management accounting accumulates cost data but classifies them

into relevant costs to aid management decision-making. Discretionary costs
are incurred at the discretion of the management. A percentage of profit
may be used for research and development. Unless discretions are
compulsions, these should not be treated as relevant costs.

Self Assessment Questions 5:

1. Sunk cost is ________________________.
2. Sunk costs are not __________________ Costs.
3. A _______________________ is used for research and development.

8.9 Management Accounting Framework

For offering accounting and financial advice as well as for capitalizing the
available opportunities for future development, it is necessary that an
effective development, it is necessary that an effective frame must should
be designed. The management accountant must organize the whose
accounting division in such a way that there is prompt and immediate
recording of the entire information flow into the department from functional
and service department. The frame must concentrate on.
 Getting rid of routine work
 Reporting actual and planned performance
 Fixing organizational responsibilities
 Application of new modern and modified practices of analyzing and
interpreting results.
 Designing of sound and efficient organization taking into account the
native and size of the business unit.

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8.10 Functions of Management Accounting

Management Accounting functions nay be said to include all activities with
collecting, processing, interpreting and presenting information to
management. More specifically, the functions are as follows:
Forecasting and Planning: Short and long term forecasts are very
essential. Planning the future operations of a business is crucial. Necessary
information and data for forecasting should be provided from time to time.
Various tools and techniques should be made use of.
Organizing: Organizing of finance and accounting functions is an important
function of management accounting.
Coordinating: Coordination increases the efficiency of an organization and
maximizes its profits.
Controlling performance: The management accounting is very helpful in
controlling the financial performance of the organization through financial
reporting, budgeting, financial analysis.
Communication: It is an important medium of communication. The
management reporting mechanism is a typical example of communicating
the results to the superiors.
Other functions: Management accounting serves in a number of other
ways. It supplies useful information to different functional authorities. It
provides accounting information and advice for price determination and
pricing decisions. It also helps in making certain strategic decisions,
decisions regarding seasonal or temporary suspension of production, make
or buy decisions, replacement decisions.

Self Assessment Questions 6:

1. Management functions include ________, ________, ________,
_________ .
2. Controlling performance is done through ______,________,________ .

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8.11 Special Features Of Management Accounting

Accounting principles are man-made. Unlike the principle of natural
science, accounting principles were not deducted from axioms, nor is their
validity verifiable by observation and experiment. They have been evolved
as “ necessity is the mother of invention” Based on this the special features
are:
1. Selective in Nature : It is technique of selective nature. It picks up
only those data which are relevant for decision making.

2. Provides Data : The function is to provide data and not the decision. It
can inform but it cannot prescribe.

3. Future oriented: It helps in planning for the future decision and hence
future oriented.

4. Cause and effect relationship : M.A studies the causes of profits or

losses since the profit and loss account does not tell the reasons for
profit or losses. M.A analyses the results of different variables on the
profits and the profitability.

5. Non-Adherence of rules : M.A does not follows set rules and formats
like financial accounting. The basic task is to motivate management
action. Hence M.A is on the utility of information and not on formats
and legal presentation.

6. Economic Reality : Accounting data and information represents the

economic activities but M.A is used to guide future planning and
decision making thereby representing the underling economic realities
in a clear and unambiguous manner.

7. Goal congruence : M.A normally encourages all employees to act in

a fashion which contributes to the overall objectives.

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8. Information system : An organization comprises a number of

information system or networks. In other accounting system the
information system are rarely integrated. But in M.A these are
designed in accordance with the principle of system theory to make it
more efficient.
9. Quantitative Techniques : Certain aspects of management
accounting particularly in the area of planning and decision making,
statistical and operational research techniques are used extensively,
By use of it, a particular solution is being refined for cost effectiveness.
10. Uncertainty : Conditions of certainty are said to exist when a single
point estimate can be made which will be exactly archived.
Conversely, Uncertainty exists where there are various possible
outcomes or results or values.

8.12 Merits and Demerits of Management Accounting

Merits
1. Efficient palling and effective organization which are the end product of
the system of management accounting bring systematic regularity in the
business activities.
2. Maximum return on capital employed is ensured by the use of
management accounting because it helps in the functions of planning,
coordination and control
3. Better and improved services by management to customers are assured
by this system.
4. Management accounting removes unacceptable standards or sub-
standards.
5. Industrial relations may be improved by adoption of management
accounting principles.

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6. Eliminations of various types of wastages, production defectives and

other related work deficiencies are removed with the help of
management accounting.
7. Economic uplift of community and development of nation’s economy can
be achieved by the use of management accounting.

Demerits
1. Most of the information used in Management accounting are derived
from financial accounting records or cost accounting records other
records. As such fairness and accuracy of decisions deduced depends
to a greater extent upon fairness and accuracy of these original records.
2. Decisions or conclusions derived are insignificant unless properly
executed at all levels of business operations.
3. Management accounting is a mere tool for management. It cannot
substitute for management.
4. The evolution has been on account of inter-alia development of new
theories in other sciences. Hence there is a need to have a
comprehensive knowledge and understanding of all these related
disciplines to derive the full advantage.
5. Management accounting is still in its evolutionary stage. Hence, there is
an uncertainty in its use.
6. The installation of management accounting is a costly affair and as such
it has very limited scope for its use.

8.13 Distinction Between Management Accounting And Financial

Accounting
Management accounting initially is said to emanate from financial
accounting in the sense that financial accounting in the beginning designed
to supply information in the form of statements for management use. In fact,
both management accounting and financial accounting are complementary

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in nature to each other. But they are distinguished in terms of kind and
relative importance of the problems involved
Area Financial Accounting Management Accounting
Objective Limited to the preparation for Information is collected for
external use internal communication and
use.
Process Recoding of financial Data is collected for internal
transactions use
Nature It is objective It is Subjective
Flexibility It is rigid It is flexible
Data Emphasis on Past data It lays stress on future
Precision It is precise It is approximation
Legality It is a legal Document It is voluntary
Unitization It covers entire organization It is based on activity,
Department, Division
Audit Compulsory Voluntary
Publication Mandatory Voluntary

Terminal Questions
1. Briefly explain the merits and demerits of Management Accounting.
2. Distinguish between Management Accounting and Financial Accounting
3. Describe briefly the scope of Management Accounting.
4. Describe the functions of Management Accounting.
5. Define Standard Costing and Variance Analysis.

Answer for Self Assessment Questions

Self Assessment Questions 1:

1. True
2. False
3. True
4. Fine-tuned

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Self Assessment Questions 2:

1. To prepare financial statements
2. Formulation of policy and taking decision.
3. Break-even analysis, Costing, Budgeting, Ratio analysis, Variance
analysis.

Self Assessment Questions 3:

1. Most powerful.
2. Planning and appraisal

Self Assessment Questions 4:

1. Financial ,external reports, Accounting.
2. Analysis and interpretation of financial statements

Self Assessment Questions 5:

1. Past cost
2. Relevant.
3. percentage of profit.

Self Assessment Questions 6:

1. All functional Activities
2. Financial documents.

Answer for Terminal Questions:

1. Refer to unit 8.12
2. Refer to unit 8.13
3. Refer to unit 8.3
4. Refer to unit 8.10
5. Refer to unit 8.6.

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